How to Practice as a Day Trader With Paper Trading
Day trading has become incredibly competitive in recent years with the surge of high-speed trading and algorithmic trading taking place in the markets. The good news is that many online brokers have enabled so-called paper trading accounts to help traders hone their skills before committing any real capital.
In this article, we will look at how to setup and practice day trading without risking any capital by using paper trading tools from popular online brokers.
What is Paper Trading?
Paper trading is another term for simulated trading, whereby individuals can buy and sell securities without risking real money. While it’s possible to backtest trading strategies, traders may be tempted to use current information to make past trades – known as the look-ahead bias – while the wrong backtesting dataset could involve a survivorship bias. Survivorship bias is the tendency to view the performance of existing funds in the market as a representative sample of the overall.
Investors may be able to simulate trading with a simple spreadsheet or even pen-and-paper, but day traders would have quite a difficult time recording hundreds or thousands of transactions per day by hand and calculating their gains and losses. Fortunately, many online brokers and some financial publications offer paper trading accounts for individuals to practice with before committing real capital to the market, which enables them to both test strategies and practice using the software itself.
Setting Up a Day Trading Account
Day traders should ideally paper trade with the same day trading broker that they plan to use for their live account since it will be as close to reality as possible.
The most popular day trading brokers are Interactive Brokers and TradeStation, which both have fully-featured simulators that even work using their automated trading rules. Day traders using these platforms will need to open an account to use the simulator, which might mean depositing the minimum funding requirements. The good news is that they can use the simulator before making live trades with their capital.
Online brokers such as Fidelity and TD Ameritrade also offer clients paper trade accounts. Investopedia provides a free stock simulator that can be used for paper trading.
It’s important to keep in mind that there are still some differences between simulated and live trading. On a technical level, simulators may not account for slippage, spreads, or commissions, which can have a significant impact on day trading returns. On a psychological level, traders may have an easier time adhering to trading system rules without real money on the line – particularly when the trading system isn’t performing well.
Paper Trading Tips to Keep in Mind
Day trading practice depends largely on the strategy that’s being used to trade. For example, some day traders are focused on “feel” and must rely on paper trading accounts alone, while others use automated trading systems and may backtest hundreds of systems before paper trading only the most promising ones. Traders should choose the best broker platform for their needs based on their trading preferences and paper trade on those accounts.
When paper trading, it’s important to keep an accurate record of trading performance and track the strategy over a long enough time horizon. Some strategies may only work in bull markets, which means that traders could be caught off-guard when a bear market comes along. It’s important to test enough securities in variety of market conditions in order to ensure that their strategies hold up successfully and generate the highest risk-adjusted returns.
Finally, paper trading isn’t a one-time only endeavor. Day traders should regularly use paper trading features on their brokerage accounts to test new and experimental strategies to try their hand in trading markets. Simple mistakes can be incredibly costly for day traders that risk tens of thousands of dollars in hundreds of trades per day. This makes paper trading an integral part of long-term success.
The Bottom Line
Day traders face intense competition when it comes to successfully identifying and executing trade opportunities. Fortunately, most online brokers offer paper trading functionality that empowers day traders to practice their skills before committing real capital. Traders should take advantage of these features to prevent making costly mistakes and maximize their long-term risk-adjusted returns and performance.
(For more, see The Top 10 Brokerage Firms for Day Trading.)
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